1. Field of the Invention
The present invention relates to the field of structured financial products. More particularly, the present invention relates to a method and system for offering mandatory convertible securities, such as dividend enhanced common/convertible stocks (DECS), with acceleration triggers for securities conversion.
2. Background
As known in the art, structured financial products are financial instruments that are issued and sold by business entities (e.g., corporations) to investors for capital-raising activities. Typically, structured financial products are particularly designed and created by investment institutions for the business entities to meet the specific capital-raising needs of such entities. In turn, investors purchase structured financial products, focusing-on payoff patterns (i.e., appreciation and/or income) of the products, to address their specific investment objectives. As referred herein, an investor can be an individual, a group of individuals, an organization, or a business entity.
One of the many structured financial products in existence today is the dividend enhanced convertible stock (DECS). As understood in the art, a standard DECS (also referred to as PRIDES, PEPS, MEDS, SAILS, PIES, or other names) is basically a convertible security that is often issued by a business entity as a fixed income instrument, e.g., a bond or a preferred stock, with an attractive yield (i.e., an enhanced dividend) and a special feature, namely, an automatic conversion (typically with a conversion premium) into a common stock at a future time. The conversion typically works as follows: on the mandatory conversion date each fixed income instrument will convert into one share of common stock if the share price on such date is below or at the same value as the share price on the date the fixed income instrument was issued; however, on the mandatory conversion date each fixed income instrument will convert into less than one share of common stock if the share price on such date is above the value of the share price on the date the fixed income instrument was issued. An investor see DECS as an attractive investment because he or she earns a higher income return from the enhanced dividend of the DECS than he or she would have as a common stockholder. Hence, the investor gives up some upside participation in exchange for the downside protection (i.e., lower downside risk). On the other hand, the business entity sees DECS as an attractive means to raise capitals with high-equity credit, almost as high as issuing common stock from a rating agency's perspective, and to attract a different pool of investors.
A major drawback with the standard DECS structure is that based on the current U.S. tax codes, there is no tax deductibility on the enhanced dividends that the DECS issuer has to pay out to the DECS holders. Hence, another structured financial product named the Upper DECS was created in the financial markets to address this drawback. As known in the art, the Upper DECS structure differs from the standard DECS structure in that the Upper DECS combines several securities into a single investment unit. Particularly, the Upper DECS combines a fixed income instrument having a certain maturity date (e.g., a five-year fixed income instrument) and a coupon (i.e., enhanced dividend) with a forward purchase contract that obligates the investor to purchase a certain number of common-stock shares (e.g., a three-year purchase contract) through the remarketing of the fixed income instrument. Hence, when an investor purchases an Upper DECS, he or she in effect purchases a fixed income instrument and a forward purchase contract. However, the entire proceed that the investor pays for the Upper DECS first will be allocated to fixed income instrument, and none is allocated to the forward purchase contract. For instance, when a first investor pays $100 for an Upper DECS with a five-year fixed income instrument and a three-year purchase contract at year 0, the entire amount of $100 is first paid to the issuer for the fixed income instrument. At year 3 the purchase contract matures, and the first investor is required to satisfy the contract by purchasing the contracted number of common-stock shares with a conversion premium.
To ensure that the first investor has the requisite funds to purchase the common-stock shares, the Upper DECS requires that the fixed income instrument be remarketed (by a remarketing agent) at year 3 to a second investor in order to raise another $100 for the first investor to purchase the shares from the issuer. Because the fixed income instrument has a five-year maturity date, it will remain outstanding for another two years, wherein at year 5 the issuer pays the second investor $100 to satisfy the fixed income instrument. Of course, the first investor receives the enhanced dividend as an Upper DECS holder from year 0 to year 3, and the second investor receives the enhanced dividend as an Upper DECS holder from year 3 to year 5. As mentioned earlier, a benefit of the Upper DECS over the standard DECS includes the ability of the issuer to have a tax deduction paid out on the fixed income instrument coupon, i.e., the paid-out enhanced dividend.